Central bank demand should boost gold further, says F&C

Market practitioners expect the world’s central banks to boost their buying of gold this year, but investment demand should remain volatile. Overall, the analysts expect gold’s price to rise.

The expectation of central bank buying bullion comes after central banks already increased demand by 164% in the first half of 2011.

“It is likely to be higher still this year,” said Ted Scott, director of global strategy at F&C.

“The demand for gold as a reserve asset should accelerate as it becomes evident that the trend towards currency debasement through increased printing of money is likely to continue.”

Scott said the main reason gold had reached $1921 per troy ounce in September was the “looming failure of fiat paper money currencies”.

He pointed to the European Central Bank’s recent providing €500bn of liquidity as “tantamount to the creation of new money”, and said if the UK and Europe fell into recession, that would probably lead to “even more printing of money [and] the risk of eventual high inflation and currency debasement will grow accordingly.

“All this will add to the lustre of gold as an asset because it is the only major asset that does not represent somebody’s obligation to pay. There is a finite supply of gold in the world where the supply is only growing at a small rate as new stock is mined each year. This means that it cannot be debased like a paper currency where the potential supply is limitless.”

Scott said the debt crisis showed that “without the discipline of gold as an anchor of the global monetary policy, there has been no check on government deficit spending, as there is no limit on the amount of debt that can be issued.

“Central banks are now adopting the strategy of printing money, ostensibly to provide a necessary stimulus for economic growth. But in reality [they are printing money] to discharge debts – buying government bonds and other interest bearing assets – and to erode away the value of those debts through inflation.”

Scott said some central banks – notably China’s – has recently adopted the strategy of buying gold, and selling US Treasuries even as Treasuries’ price rose in uncertain times.

He added, however, investment demand would be volatile.

Sometimes it would not reflect fundamentals, he added.

He pointed to sharp falls in the gold price late in 2011 partly because of selling of gold ETF positions by hedge fund Paulson & Co, which suffered sharp losses in some of its hedge funds in 2011. The funds suffered redemptions as a result.

“The [gold price] weakness is likely to prove only temporary, especially if the reasons for the period of extreme stress are not quickly resolved. This has been the case since 2008.

“If there was another financial catastrophe as a result of a breakdown of the Eurozone, it is probable that gold would fall for similar reasons. But it would also make it even more likely that policy makers would increase liquidity still further…to erode away the value of the debt. The only way that savers can protect themselves would be to invest in a real asset like gold.”